I am a CPA in Texas with an MBA from the University of Chicago. I have seen a lot and made many mistakes. Hopefully by now I will have learned something from them. Just as importantly, you may learn something from my mistakes. You can e-mail me by clicking on my "View my complete profile".

Saturday, June 13, 2009

Whose Watching?

"The Big Four accounting firms are used to embarrassing headlines about their purported misdeeds. After all, the past decade has seen one business catastrophe after another at companies audited by the major firms. Witness the scandals at Tyco, WorldCom and Xerox. ... In investor lawsuits filed in recent months, BDO Seidman [BDOS] and McGladrey & Pullen stand accused of shoddy audits and signing off on the books of fraud-ridden businesses and investment funds. The cases, together with a string of earlier ones involving the two firms, raise unsettling questions about the level of confidence investors can put in financial audits. ... The gray area centers on what is reasonable, an issue that often plays out in the courts because accounting firms can be one of the only solvent players left when a company goes down. ... [BDOS] had audited [ES Bankest LLC] and concluded its books were free from material error. ... 'Auditors are supposed to have professional skepticism, and that is just inconsistent with the client relationships that they try to preserve to keep the money flowing,' [Steven] Thomas says. ... [BDOS] ... also is contesting a civil lawsuit from the collapse of Le-Nature's Inc., a Pennsylvania iced-tea producer shuttered in 2006 after allegedly faking $240 million in revenue, according to forensic accounting undertaken by a bankruptcy court. [BDOS] auditors had certified that Le-Nature's financial statements were free from material error. ... For McGladrey & Pullen, some tough questions have come from Frederick J. Grede, a Chicago bankruptcy trustee who claims the firm's auditors actively participated in the 'looting' of Sentinel Management Group, a $1.4 billion investment fund that failed in August 2007. ... According to New York Attorney General Andrew Cuomo, [J. Ezra] Merkin repeatedly lied to his customers about what he was doing with the $2.4 billion they had given him. ... The Merkin funds were audited by [BDOS], which attested that the books were free of material error. ... In a lawsuit [New York Law School] blames [BDOS] for not telling investors about Merkin's alleged sleights of hand. Exhibit A: the 2007 audit of Ascot, which lists the fund's assets on a week-to-week basis, but doesn't mention that just one broker, Madoff, held nearly all those assets. ... But New Jersey lawyer, Alan Wasserman, who is preparing another case against [BDOS] on behalf of Merkin investors, says Merkin's heavy reliance of Madoff is a 'red flag any accounting firm should have seen' and noted. ... In the view of Richard L. Kaplan, a law priofessor at the University of Ilinois, a diligent auditor should go to source documents to verify the financial statements it is scrutinizing. If a fund claims it has cash in a bank account, auditors should get records directly from the bank, he said. Kaplan has advocated tougher oversight of accounting firms. Still, he acknowedged there are limits. 'A very determined crook.' he added, 'will deceive virtually any auditor'," my emphasis, AC Thompson and Jake Bernstein at Barron's, 11 May 2009.

Yes, Thomas, one problem with CPA audits is the fee arangement. Another is the SEC. I disagree with Kaplan, CPAs have too much regulation now. It doesn't work. The SEC should eliminate the "large accelerated filer" and "accelerated filer" concepts. It should give registrants 120 days to file: 10-Ks and 60 10-Qs. But the "analyst community" will scream. So? CPAs have enough excuses for shoddy work, short SEC filing deadlines should not be another. Go "to source documents", how novel. What did PWC do at Satyam? If you haven't recently, read a 10-K. The SEC has registrants include much repetitious material. Why?

An auditor's scope, by law, is not to catch fraud. That responsibility is solely that of the IA. Until more pressure is put on firms to actively pursue fraud, methodologies and procedures will never be in tune.

Anonynous:I have no misperceptions. If there is material fraud, and the CPAs didn't catch it, my assumption is they DIDN'T DO THEIR JOB! Let the CPA in question prove otherwise. I'm not talking about immaterial defalcations, like say stealing a few pieces of inventory. What law are you talking about? Some CPAs claim they have no responsibility to find fraud and have said this for decades. That's why we have absurdities like: SAS 53, 1988; SAS 82, 1997 and SAS 99, 2002. CPAs want to say, "we're not responsible". I say, then your audits are usless! Ad hominem attack notice, are you a Big 87654 partner? In the "Current Text", AU 316.83 requires CPAs to dcoument "Consideration of Fraud", whatever that means. I say it's just more self-serving claptrap. AU 316.01 reads in part, "The auditor has a responsibility to plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatemnt, whether caused by error or fraud". Read it. If a CPAs actions are "reasonable" is for a jury to decide.

If there is massive colusion and falsified documents you may not catch the fraud. It is easy to be a Monday Morning quartback. If there is any regulation it should be that there should be a minimum fee and hours requirement to do an audit. Otherwise you are always going to have people cut corners and try to do less work. However most business are looking at price rather than quality.